A good fund-of-funds1 is a passive investor’s Swiss army knife. Open it up and you’ll find several index trackers inside, offering you exposure to a variety of assets – invariably global bonds and equities but also in some cases property, cash, and more.

The joy of fund-of-funds is that they are as simple as a Wurzel and relieve investors of chores like:

Will you be 80:20 or 60:40 or what? You need to know to properly draw up your investment plans.

But L&G, BlackRock, and Architas all reserve the right to roam. For example, BlackRock Consensus 60 can range anywhere from 20% to 60% in equities and Architas doesn’t even define its boundaries. It makes long-term planning hard and subject to the whims of someone else.

Instead of well-defined rules, the fund literature runneth over with bullshit bingo-talk about dynamic asset allocation processes that are, I expect, robust, proprietary and risk-managed [“House!”].

In other words, there’s a curtain of guff that prevents you from really knowing what’s going on. Which is a problem because – contrary to the marketing team’s intentions – that makes me more nervous about the product, not less.

I think these funds are really designed to reduce friction for financial advisors. They get a low cost, low maintenance package that neatly complies with the risk regulations and doesn’t suck them into awkward client conversations about how believing in market-beating managers is like believing in Santa Claus.

But DIY passive investors who’ve taken the trouble to work things out for themselves are better served by the stable asset allocations offered by HSBC’s and Vanguard’s offerings.

Not your father’s ETF

So much for the fund-of-funds. What about the ETF of ETFs: db X-trackers SCM Multi Asset ETF?

A few fatal flaws get it gonged off:

It’s very expensive with an OCF of 0.89% – more than three times the cost of a Vanguard LifeStrategy fund.

Its remit is even wider than those funds-of-funds: the ETF can be all in bonds, or equities or cash depending on the mood of the manager.

It’s an active management ETF, which explains why it’s so expensive. The manager trades ETFs instead of shares but this is not a passive investing product.

There’s no more reason to buy this than any other active management vehicle. Chances are you’ll overpay for mediocre performance.

New developments

One other interesting thing to note – the fund-of-funds families are all following the trend towards greater bond diversification. Most devote a significant slice of their fixed income pie to foreign bonds, probably in an effort to combat the measly prospects of gilts.

This might make sense as far as it goes, but only Vanguard currently offers foreign bonds that hedge their currency exposure back to Sterling.

Without that hedge, foreign bonds expose you to greater volatility as overseas-denominated assets wax and wane against the pound.

Given that your fixed income allocation is meant to be as quiet as Gardener’s Question Time in comparison to the soap opera of equities, a hedged approach that offers diversification and stability is preferable.

Vanguard’s LifeStrategy funds beat most of their rivals on fees, too. Only the BlackRock Consensus funds are cheaper, but the few basis points difference isn’t worth worrying about in my view.

A final test would be a comparison of performance but very few index tracker fund-of-funds have been around long enough to make that relevant. A mere couple of funds have even got five year records, so you’re better off choosing on the basis of transparency and low cost value.

Take it steady,

The Accumulator

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i.e. Not a collection of actively managed funds or even hedge funds, which also come in fund-of-fund form. [↩]

Please clarify something for me. A fund-of-funds has an Annual Charge of its own (for instance Vanguard Lifestyle 100% has a reported 0.29%). However it is composed of underlying funds all of which, presumably, have their own on-going charges. If so, isn’t the investor paying two layers of charges? One for the underlying funds and secondly for the convenience of having then packaged in the fund-of-funds. The underlying funds typically have annual charges of 0.3% so the total charges paid for holding the underlying equities in the fund-of-funds is some 0.6%.

Perhaps I have got it wrong but I don’t really see how it can be otherwise.

With Vanguard the fees quoted are inclusive of all the management costs

With a lot of other people’s funds of funds they are not and you can end up paying 2 or more levels of fees

Generally I personally think all funds of funds are a bad idea

Since so much of the world’s equity and bonds indexes are US/European (which you can track for an annual charge of peanuts) any fund of funds ends up bein more expensive than a judiciously chosen DIY portfolio of maybe 6 funds/etfs

IMHO its not to much to ask anyone to make four comparisons once a year:
– is my asset allocation right
– are my funds costs low enough compared to the market leaders
– is my platform still cheap enough compared to the market leaders
– will my fund generate the income I want

The above is actually less work getting car and home insurance each year

@Greg and Neverland
Thanks for those comments. I found two articles (FT and Telegraph) from late 2012 both of which warned about layered fees for Fund-of-Funds.

Telegraph Dec 2012
“But this comes at a price, Mr Connolly said. “The investor has to pay two levels of fund management charges – one for the overall fund manager and another for the underlying funds, on top of any fee to their adviser. This makes them expensive.”

FT Nov 2012
“Fund of funds is a great concept in theory, but terrible in practice,” says Alan Miller, chief investment officer at SCM Private. “Investors are marketed fund of funds as a way of spreading risk and increasing diversification. However, these advantages are frequently more than offset by the extra significant layering of costs and fees.”

I would love to think that Vanguard play it straight……I am a Jack Bogle fan….but I cannot find anywhere on their website that spells it out. I would appreciate it if you could point me to where that is done.
Cheers.

@ Paul S – No layered charges, the OCFs (plus spreads / dilution levies / platform charges) are what you pay. Yep, certain fund-of-funds have been guilty of sharp practices but not these passive types. Each company except Architas uses its own brand funds within the wrapper to keep costs down. Architas roam free across different product providers and as such are more expensive than the rest: with OCFs in the 0.6+ range.
HSBC are in the 0.5s
L&G are in the low 0.3s
Vanguard are 0.29
BlackRock are 0.23 – 0.29.
However, I think the structure of the various offerings means DIY-ers should choose Vanguard or HSBC and then the price differential makes that choice clear.

had to consolidate that to a lifestrategy when they brought in the £2 tax

now i’m having to shift platform due to the .45% tax

i’m keeping the sipp though as its small and still cost effective so i will still have an hl account – i could repopulate my now empty fund acc with etfs, no annual management fees and i think i could use the new regular trader to get dealing down to £1.5 – could be worth a go..

Great post, sad to see the market of these types of funds is so poor. I was trying to find out what the heck was in the L&G funds but its so difficult its just not worth it. That’s the beauty of vanguard – they are 100% transparent.

I think the great thing about Lifestrategy is it stops you messing with things! I have some and a mix of other trackers, the Lifestrategy always trumps my total performance – although it will take years before I know if my slightly different passive allocation (more time hale) will be better.

I receive a final salary pension. One of my financial risks is that the pension scheme gets into trouble, falls back on the PPS, and so loses me nearly all of my inflation protection. How should I best protect myself from this? I should say that I am disinclined to invest in index-linked gilts because not only are their returns unattractive, but also because the sort of economic developments that might torpedo my pension scheme might well be the sort that lead HMG to default on the inflation-protection of ILGs. A bit of gold might be wise, but what else?

Now that many of our SIPPs and ISAs have a capped annual charge rather than a monthly fee per holding, I’m thinking it might be an idea (and interesting) to split our single investment in a fund of funds up. So rather than having the whole SIPP in one place like Vanguard LS80, maybe put a third in the Black Rock consensus, a third in L&G and leave a third in Vanguard LS80.

It wouldn’t cost anymore now that the fee structure has changed, and it’d be very interesting to see which performed better over a number of years.

It would also lower your potential losses if one of the companies involved turned bad.

Hi,
Wow! What a fantastic website. I have learnt so much in the last few weeks reading this, so thank you for that.

However, my head is doing somersaults with this RDR shenanigans, so wondered if anybody would offer their opinion!
I started investing in the Vanguard Lifestrategy funds less than a year ago, I have around £6k in an ISA and 9K in a SIPP, both at HL.
Due to the small amounts, I wasnt going to move them but have just seen that Charles Stanley (for the ISA) also do the VLS with a slightly cheaper platform fee. I currently pay just £100 per month into each.

I am thinking I should stay true to all i have read about maintaining low costs, but in my case is it worth it? Especially with transfer costs etc.
Or should I just set up a new ISA with CS in April pay all the £200 p/mnth into that whilst moving the HL ISA into the SIPP at a similar rate?
I know its not a major thing for some of you seasoned investors, but any opinions would be greatly appreciated.

@ Acky – I probably wouldn’t at the moment unless you can get HL to waive transfer costs. After June 2 HL are axing their £75 SIPP transfer fee, so you’d be paying £55 to transfer each account. Calculate how long it would take you to recoup that versus your next best option: http://monevator.com/compare-uk-cheapest-online-brokers/

The broker market is going through a massive period of flux. Things may be clearer in 12 months or so, so don’t feel too much urgency to pull the trigger.

@ Vestor – You’re giving up transparency on your broad asset allocation in exchange for some comfort that you’d be better protected if a company like Vanguard went bust and your assets weren’t ring-fenced. A remote possibility but not impossible. Only you can decide if that’s worth it. I’d personally rather know what my asset allocation is but that’s just me.

If you do decide to diversify funds then pay attention to where they’re domiciled. If they’re not based in the UK (but are say in Ireland) then investor compensation protection may be less or non-existent:http://monevator.com/investor-compensation-scheme/

@Acky
You have a sensible set-up at the moment. For small amounts of money, it isn’t worth chopping around once you’ve got someone fairly competitive as prices will change in the future too!

A 0.1% improvement in fees on £15k is £15. Remember your time is valuable too! Obviously, as the value of your savings goes up you should take a closer look. If you were in Alliance Trust, say, I would tell you to move as their flat fees now punish small holdings, but HL are ok here.

I’ve currently got my SIPP (YouInvest), invested in IT’s. I’m 15 years off retirement but starting to think that maybe I should accept that I’ll be better off invested in trackers (and more diversified). Reading Ian Vestor’s comments above leads me to a similar question, what is the maximum amount I should consider investing with one company? I wouldn’t like to move everything to VLS only for them to fold (unlikely I know but never say never!)

Would I be better splitting the pot into 4 and going with HSBC, L&G, Vanguard and BlackRock?

In a strange way I’m attracted to the way the Black Rock consensus and Arhcatis funds are ‘managed’. I fully understand the concept of rebalancing and asset allocation within a SIPP, but it seems to me that these other funds that lack transparency are attempting to offer some degree of management within a fully passive tracker fund of funds.

I assume that they’ll basically shift the weighting in and out of the different funds according to larger scale global movements and trends. So if gilts/bonds start sliding and equities start booming, they’d re-weight in that direction and visa versa.

Obviously this blows in the face of true passive index investing, but is it not possibly an interesting hedge in some respects? Or am I showing my naivety here? Feel free to say yes!

@ Vestor – all passive funds will move in concert with the aggregate decisions of every investor in that particular market – that’s how a tracker operates. But these products overlay that with an extra level of active management ‘sell’ – a group of investors who have been shown to underperform the market time and time again. So I think that aspect is a mirage. I don’t blame you for wanting to diversify beyond one company. I think that’s a good idea. But doing it with these products means not being in control of your actual asset allocation.

Thanks for the help Sir. I’ll duly note your comment and avoid those funds.
Maybe just going 50:50 with the HSBC and VLS funds is the answer. As I say, it’d be interesting to see if one out performs the other over the longer timeframe.
Maybe also worth checking out the new cheap tracker fund of funds that HL have promised us.

@Harry
I personally like ITs and have about the same in ITs as trackers. I think a sensible approach is to have a backbone of a big, cheap tracker. (Vanguard LifeStrategy is the one I’ve always referenced but now there are others, they deserve a closer look. e.g. This article!)

Then one can add a bit of flavour with some ITs and potentially other trackers. This bit is entirely optional though! (For my sins, I do have a few active OEICs too.)
I think ITs like CGT, RICA, PNL, BACT can be used effectively to lower the overall volatility while maintaining pretty much the same returns. However, the big problem now is you have to rebalance! Therefore, it is far more effort than just having a portfolio-in-a-box.

If you have enough money going in, and choose income units in your big tracker, you may be able to achieve rebalancing by directing new money to the required places, keeping it cost effective. However, you’ve added a human judgement element into the equation, and we’re rubbish!

Some ITs are pretty cheap and can be cheaper after platform fees are applied to trackers. e.g. SMT, TMPL have OCFs of 0.5% Mostly it is _cheap_ funds that do well, rather than simply trackers!

I’m not convinced about passive investments in bonds, so a strategy I’ve taken in one of my accounts is to use the Vanguard LS 100% for my equities and use an M&G active bond fund for the fixed income allocation.

Obviously I will have to re-balance the broad equity/bond spread manually but I feel a bond fund can often add value over a simple passive bond investment. I don’t feel the same way about active equity funds!

I also like IT’s & they’re doing ok but i’ve no bond allocation. I’ve got 20% cash but no bonds. My cash isn’t earning anything but then people seem to be bearish on Gilts and I don’t think corporate bonds (HDIV, CMHY, IPE) offer me diversification from my equities? Can you get Govt bond allocation with IT’s? or is it better to use the tracker route?

@neverland
Point taken! However, ITs only make up a fraction of my holdings and I think there are enough advantages to make the discount risk worth taking.

@Harry
Some of the ITs I mentioned have a big slug in bonds, though don’t rely on them to stay that way long-term as it is a tactical choice! I think with the returns for Gilts projected to be so low, a tracker is probably the best way as fees will be even more important! I like BACT as it can get hedge-fund like behaviour without the fees, all while curing cancer! Watch out for the premium though!

You can get plenty of ‘alternative bonds’ via ITs, which might be worth a look, but they are no substitute for high-quality debt! TFIF, AEFS, NBLS, DREF, JGCI, RECI, SWEF etc. (HDIV you’ve mentioned but don’t think it’s a normal bond fund!) I’d imagine most people would want to steer clear! It’s just making things more complicated!

I want to put another £8k (lump sum) into the market but I’m already heavily overweight in UK All Share Trackers and nervous about the current lofty heights of the US. I already make much use of Vanguard trackers. I also intend to drip feed some additional money into emerging markets over the next year or so as they appear to be out of favour.

One option for my £8k lump sum that I have been considering was Vanguard LifeStrategy 80 or 100. However, the high weighting of US and large UK puts me off so I thought about making up my own fund of funds by putting equal amounts of £1k into each of 8 different cheap trackers.

The ones I’m thinking of are listed below. I will probably use ACC versions of HSBC funds where available. Given the low amounts I am very unlikely to re-balance this portfolio within a portfolio, at least for 2 or 3 years, so it will be interesting to watch how each market’s performance compares to the others and also to my other holdings including LifeStrategy 80 which I already hold.

Great reading the above comments and the support for vanguard lifestrategy. I am transferring a 180k sipp currently managed by an expensive and useless IFA so I can reduce the fees. Seriously considering lifestrategy 100 however he yield is so low at just over 1% and no one seems to be mentioning that. Am I missing something here? Why would I put up with such low yield when there appear to be such better options in the 3-5% yield band out there?

I’ve got no problem with the regions you wish to invest in, I don’t really get why you would overweight, for example, the Pacific yet are worried about overweighting the UK. Here’s a piece to help you come up with a more grounded asset allocation: http://monevator.com/asset-allocation-construct/

@ Ben – not sure what better options you have in mind? I’m concerned with overall return rather than yield as an isolated component of that.

@ The Accumulator, thanks for the response. I’ll take on board your list of HSBC-beating trackers and re-consider.

Regarding the weightings, the reason is that this additional lump sum only represents about 5% of my investment in funds and overall I’m massively overweight in UK large and underweight everything else. This additional money will address that only slightly but is more for fun. I want to spread this money across different markets but I’m not convinced that adopting conventional weightings is the way I want to do it – unless I was convinced that US will outperform the others or that I want my portfolio to move in line with the world.

I have no idea which market will perform best, though with emerging markets being so out of favour at the momement it must be in with a good chance, so I thought I’d try giving every market an equal weighting in this portfolio within a portfolio and then it would be interesting to see which performs best in 2014 and which in 2015 and so on. Whichever it happens to be wouldn’t matter to me as I would have it, although I would also have the worst as well.

It just feels to me that that ths would add a bit of interest to my portfolio whilst still remaining passive.

I wonder if anyone could help me with a question. I don’t see any article on here discussing this in much detail. I currently have around £45000 in a Vanguard life strategy 60% accumulation fund that’s not in an ISA wrapper. If I want to gradually bed an ISA and move around £3000 of this a year into an ISA account as I am saving £12000 per year as a target.

Do I have to tell HMRC if I use my capital gains allowance to be able to claim it per say. I wonder if I am wrong in having thought previously that if you don’t go over the £11000 mark in gains per year then you do not have to tell the HMRC. Upon reading up on this, I have seen something that says you tell HMRC if you make over £2500 from capital gains (not sure if reading this right).

I also seem to have misunderstood this in that if I was to sell part of the fund, it is only the gain from when I bought it that is counted. And it seems that if you don’t use the allowance, you might suffer more tax for example. If my fund grows by £10999 one year and £109999 the next, if I don’t sell after 1 year but sell after 2 I will have to pay tax on £10098. Therefore, it is better to sell and purchase back after 1 month to in essence use the allowance? Leading back to my first query. Do you need to tell HMRC This even if you are below the allowance?

Kind regards,
Thanks for your time
Chris

I would love it if an article was written for people who have a fund invested outside of an ISA discussing here tax issues as if I was not able to understand this correctly, I think others may be the same.

I have been working on another article with a worked example, but got bogged down in explaining why (legally) avoiding taxes is important and isn’t morally indefensible.

Whenever I write about reducing/avoiding (not evading!) tax I get a some flak in comments and over email for whatever reason, but anyway I will push through the thrown tomatoes and publish the article eventually!